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Duality in Cyclical Trends in European Union Confirmed:

Duality in Cyclical Trends in European Union Confirmed: This article differentiates the euro-economies in terms of the degree of synchronization with the cyclical position of Germany perceived herein as a hegemon economy. The purpose of this study is the identification of the euro-economies that can be identified as an effective monetary area in terms of similarity in economic structure with German economy. The cyclical position is expressed as an average of absolute values of differences of the output gaps between euro-countries and Germany. This procedure is supplemented by correlation and comparative analysis and with the assessment of empirical findings. Two groups are identified according to similarities in cyclical positions. Similar economic performance was ascertained in Austria, Belgium, France, Luxembourg, the Netherlands, and Finland, the economies of which are thus labeled as an effective currency region in the sense of optimum currency area. The assessment of the future development in Eurozone is made taking into account the current political and economic circumstances and the outputs of empirical analyses. Keywords effective currency area, optimum currency area, monetary policy, cyclical heterogeneity, Eurozone Krugman (2013) perceived Mundell’s theory of the opti- Introduction mum currency area as a theory about finding a balance between “The art of economics consists in looking not merely at the potential gains and losses in a qualitative sense. The success of immediate but at the longer effects of any act or policy; it monetary integration is conditioned by the existence of labor consists in tracing the consequences of that policy not merely mobility, a similar economic structure, and fiscal integration for one group but for all groups” (Hazlitt, 1946, p. 1). This (Kenen, 1969). The argument for the requirement of the com- thesis was, according to some economists (e.g., Krugman, pliance of a similar economic structure of the participating 2013), ignored in the case of the single currency euro states is to minimize the occurrence of such asymmetric shocks introduction. that would otherwise require different monetary policy inter- The theoretical and empirical aspects of the single mone- ventions (i.e., an effort to reduce cyclical heterogeneity in the tary policy were studied by many authors; among those stud- monetary union conjugate countries). The argument for the fis- ies, Mundell (1961) can be seen as one of the most significant cal integration policy leans on utilizing the opportunity of contributors. Mundell in his early work provided an analyti- mutual insurance against the asymmetric development of cal framework outlining the conditions for the thriving func- united economies; in such a case, it is possible for the country tioning of the monetary union. The main prerequisite of affected by a negative shock to obtain a positive net transfer successful monetary integration is linked to the characteris- from a country not affected. Fidrmuc (2015) remarked that if tics of the geographic area that has a high degree of labor the asymmetries are temporary, the effects of such an applied mobility factor inside and vice versa labor immobility factor “suboptimal” fiscal policy are short term and may be offset by outside (the optimum currency area). For that reason, such an the benefits of risk sharing under the terms of mutual fiscal area should have one currency inside and outside; it should insurance. However, if the shocks are of a permanent nature, have a flexible exchange rate; the labor mobility is seen as a fiscal transfers will become largely deterministic and unidirec- substitute for the exchange rate variability. As regards the tional with long-term costs burdening the donators. idea of monetary integration of Europe, Mundell literally says, “The question thus reduces to whether or not Western The Institute of Technology and Business in České Budějovice, Okružní, Europe can be considered a single region, and this is essen- Czech Republic tially an empirical problem.” In his later work, Mundell Corresponding Author: extended his analysis with a requirement for the stability of Simona Hašková, The Institute of Technology and Business in České the purchasing power of the integrated currency region Budějovice, Okružní 517/10, 370 01 České Budějovice, Czech Republic. (Fleming, Johnson, & Swoboda, 1973, p. 1). Email: haskovas@post.cz Creative Commons CC BY: This article is distributed under the terms of the Creative Commons Attribution 4.0 License (http://www.creativecommons.org/licenses/by/4.0/) which permits any use, reproduction and distribution of the work without further permission provided the original work is attributed as specified on the SAGE and Open Access pages (https://us.sagepub.com/en-us/nam/open-access-at-sage). 2 SAGE Open The economic slump in Europe activated by the 2007 performed empirical analysis, which showed that larger dif- financial crisis renewed the debate about the relationship ferences in output gaps indicate a more serious fluctuation between the economic cyclicality of the participating coun- in the phase of the economic cycle. tries and the efficiency of a monetary union in a situation of a nonexisting fiscal stabilization mechanism, limited mobil- Methodological Approach ity of labor factor, and economic heterogeneity of the mem- ber states (this issue was analyzed based on empirical data The analysis of cyclical synchronization/nonsynchronization given in Montani, 2011, or Collignon, 2013). of the monitored euro-economies entering the Eurozone In the context of the 2007 financial crisis, Fingleton, before and inclusive of 2002 compared with the German Garretsen, and Martin (2015) examined the vulnerability of economy in the period 2002-2016 of the economic cycle is heterogeneous economies bound by the euro. Their findings based on the quantification of the average difference of out- indicate that the larger the asymmetry of shocks across put gaps (Miles & Vijverberg, 2016, assessed cyclical syn- regions sharing single currency is, the more this area devi- chronization of Eurozone by means of a method of switching ates from the optimum currency area in terms of the mone- Markov models examining the changes in output). The out- tary policy implemented. Cancelo (2012) presented empiric put gap of each economy in a given year is the difference of evidence that the foundations, which explain the formation the real product (Y) and the potential product measured in of the national cycles across the European Monetary Union percentage of Y. The average of absolute values of differ- aggregated through the crisis, were already latent in 2007. ences of the output gaps of the monitored economies ( G ) Several authors have examined the influence of German (where G signs for an output gap of the ith economy at the interests on the formation of the European monetary policy. time t) and the reference economy ( G ) (wherein index G Kaltenthaler (2002) argued that the nature of the European denotes the output gap of reference economy R at the time t) monetary policy was influenced by German economic in the period t = 1; n is quantified by the relationship shown interests rather than the interests of European policy elites. in Equation 1; it defines the respective average deviation of From another perspective, the nature of the European mon- the cyclical position of the ith economy observed from the etary policy has been examined by Bulmer and Paterson cyclical position of the reference economy R. (2013). It focused on the analysis of the evidence of the t t hegemonic role of Germany, which is considered to be a X =⋅ GG − . (1) i R i key player in the field of EU policy (Krampf, 2014); spe- t=1 cifically, it deals with the interaction between Germany and The criterion defining the interface between the cyclical syn- the European Central Bank and the European Commission. chronized and unsynchronized euro-economies is the geo- Also, De Grauwe in 2013, saw the political objectives metric mean of the average deviations X calculated behind the decision to create the euro as a common cur- standardly according to Equation 2, where m stands for the rency with Germany and France being the main players in number of countries considered. Furthermore, the statistical this field; as for France, its inferior position that it occupied t t correlation of G and G is expressed and its relevance to R i in the European Monetary System initiated a proposal of the problem discussed. monetary union (as justified in Jabko, 1999, in detail); as 1/m for Germany, the ultimate goal of unification was to peren-   (2) GX =   . nially link the fates of France and Germany and thus to i   i=1   eliminate the danger of future wars on the European conti- nent (Ash, 2012). The imperfections of the criteria Y discussed by van den The purpose of this article is to differentiate the euro- Bergh (2009) are disregarded. Furthermore, it is assumed economies in terms of the degree of synchronization with that the potential output approximately expresses the highest the cyclical position of Germany (hereinafter “reference sustainable performance of the economies under the condi- region”). The cyclical position mirrors itself in the economic tion of disposable amount and quality of factors of produc- cycle in which euro-countries are found at a given time tion (Durlauf & Blume, 2008). when compared with the reference region. Within the analy- Potential product is considered to be a relatively good cri- sis, the assumption of the economic and political hegemony terion for depicting the state of the economy in the absence of Germany is accepted (based on the profound quantitative of demand and supply shocks in all markets (Gerlach & and qualitative analysis and rational arguments found in Smets, 1999). Although the identification of the disparity Paterson, 2011, and Bulmer, 2014). The synchronization/ between the real and potential product is ambiguous (it is not nonsynchronization of euro-economies with the reference clear to what extent it is, for example, a negative demand region is assessed by means of a statistical and comparative shock or a negative supply shock—both types of shocks analysis of the output gaps of gross domestic product for the within the metrics used reflect in the same direction, that is, period 2002-2016 (the data source was a publicly accessible in decline in the real output, though the monetary policy database: OECD.stat, 2016). Artis, Krolzig, and Toro (2004) response may not be identical), it can be considered as an Hašková and Vochozka 3 Table 1. The Cyclical Heterogeneity of Eurozone Countries in Comparison With the German Economy (Ranked in Ascending Order According to the Indicator of Average Deviation, X ). The average deviation from the cyclical position Eurozone of the German economy ( X ) (in % of Y for the R (the predictive power of r (correlation of output countries period 2002-2016) the regression model) [0, 1] gaps in 2002-2016) [–1, 1] Belgium 1.08 .38 .62 France 1.39 .27 .52 Luxembourg 1.4 .412 .87 Austria 1.5 .31 .56 Netherlands 1.54 .26 .51 Finland 1.93 .39 .62 Italy 2.16 .15 .39 Portugal 3.19 .008 .09 Spain 4.04 .025 .13 Ireland 5.66 .081 .28 Greece 7.73 .002 −.04 acceptable summarizing criterion (Apel & Jansson, 1999). to economies whose average deviation from the potential We agree with Mandel and Tomšík (2015) who consider the product is higher than 2.3% of Y compared with the refer- synchronization appraisal of economies according to the ence region—further referred to as Group II). growth rate as incorrect. The growth rate is a variable captur- The correlation coefficients r as well as the coefficients of ing the growth/decline of real product due to past perfor- determination R (see Table 1) can be considered as the mance expressed in percentage, which insufficiently implementation of statistical relations between the values of indicates the phase of the economic cycle in which the econ- the output gaps of the reference region and the surveyed omies are found. The product growth rates may be similar, euro-economies. These statistical measures are widely used although the phases of the economic cycle are fundamentally to explain macroeconomic relations, for example, in Bianchi different and require different interventions of monetary pol- and Civelli (2015), Kiley (2013), or Havránek (2010). icy (Grossman & Helpman, 1993). However, as Den Haan (2000, p. 3) pointed out, “uncondi- tional correlation coefficients lose significant information about the dynamic aspects of the co-movement across vari- Analysis of Cyclical Heterogeneity of ables.” In case of nonstationary variables, the unconditional Euro-Economies According to Output correlation produces spurious estimates—as they do not Gaps imply causation. Therefore, it is necessary to consider their substantive contribution to the analysis according to other The impacts of demand and supply shocks on the Eurozone standards. The degree of similarity in terms of r and R is, countries during the period 2002-2016 depict the respective therefore, assessed by means of the comparative approach positions of cyclical deviations of the monitored economies whose results are captured in Figure 1. The regression lines from the cyclical position of the reference economy. The there define a relationship between the reference region and cyclical deviations calculated according to Equation 1 are the surveyed euro-economies. This relation leans on the summed up in Table 1. The higher the value, the greater the assessment of the cyclical positions of the euro-economies of divergence of the cyclical position of the countries surveyed Ireland, Greece, Luxembourg, and Austria, and the reference compared with the reference region. region by means of the analysis of annual deviations from According to the criterion of “synchronization,” it is pos- the potential product for the period 2002-2016. sible to identify the degree of similarity of the economic The relationship between the components of the cyclic posi- cycle in Austria, Belgium, France, Luxembourg, the tion of Ireland and the cyclic position of the reference region Netherlands, Finland, and Italy (further referred to as Group (see the upper left graph of Figure 1) exhibits a low value of the I) with the German economy. Similar development is identi- coefficient of determination (R = .08) as well as a low value of fied in the countries whose average deviation from the cycli- correlation (r = .28). From Figure 1, it can be specifically cal position of Germany is located in the range [0, 2.3] learnt, for example, that when the output gap in the reference percentage of Y in the selected period (see Table 1). The economy was above the potential by 0.71%, 2.57%, 0.59% and upper border value 2.3 is given by the geometric mean of the 0.03% of Y, the corresponding values of output gaps in Ireland average deviations (see Equation 2). Conversely nonsyn- amounted to 8.46%, 9.42%, –6.31%, and –4.51% of Y. In the chronization is identified in the case of Ireland, Greece, and case of the under potential values of –1.58%, –1.75%, and Spain, and to a lesser extent in Portugal (the property of –1.9% of Y of the reference region, the Irish output gap was asynchronous development of the cyclical position is related 4 SAGE Open Figure 1. The output gaps in percentage of Y of the reference region versus output gaps in euro-countries Ireland, Greece, Luxembourg, and Austria. 7%, 7.02%, and –7.15% of Y. From this, the disproportion in cyclical deviations of Group II can, however, be deemed as the cyclical positions can be clearly seen. The right upper graph more or less disadvantaged by the single monetary policy. De compares the output gaps of the reference region with the out- Grauwe and Foresti (2016) gave reasons for such a distribu- put gaps of Greece also revealing a strong disparity in the eco- tion pointing to the loss of ability of these economies to nomic cycle (R = .002, r = –.04). The relationship between the improve the strong asymmetric division by an appropriate output gaps of Germany and Luxembourg (see the bottom left manipulation of exchange rates to correct the real flow of graph of Figure 1, with R = .412, r = .87) shows substantial goods and services within international trade and to appro- synchronization compared with previous cases. This also priately influence national interest rates (Coudert, Couharde, applies for Austria (R = .31, r = .56), whose position of the & Mignon, 2013). output gaps of Y compared with Germany is shown in the bot- The empirical development of euro-economies studied tom right graph of Figure 1. The same can be concluded in the in Barigozzi, Conti, and Luciani (2014) and Duwicquet, 2 2 cases of Belgium (R = .38, r = .62), France (R = .27, r = .52), Mazier, Petit, and Saadaoui (2015) pointed to the strong 2 2 Netherlands (R = .26, r = .51), and Finland (R = .39, r = .62). cyclical heterogeneity of Italy owing to the idiosyncratic nature that can barely be coordinated by the single mone- tary policy ( X = 2.16% of Y, which lies on the division Italy Discussion line between Group I and II; see Table 1). Coudert et al.’s The monetary transmission mechanism being changed by the (2013) analysis quantified the degree of currency over- euro introduction has in general resulted in different valuation in 2010 to which contributed the fall of net for- responses in the two groups of euro-economies (see analyti- eign assets and productivity regression in Greece, Spain, cal part above). On the basis of a distribution of the euro- and Portugal, and to a lesser extent also in Italy. Conversely, countries to Group I and Group II, let us consider that the Hardiman, Blavoukos, Dellepiane, and Pagoulatos (2016) Group I has not been significantly weakened by the single noted that Ireland began to escape the after 2008 crisis monetary policy effects. Euro-economies with the severe stagnation of Greece, Spain, Italy, and Portugal as its Hašková and Vochozka 5 Table 2. The Heterogeneity in Outputs Gaps (percentage of Y) based on empirical data and the past and current political and of Ireland, Portugal, Greece, Spain, and Italy Compared with the economic development in the European Union, submitted Output Gaps of Germany in 2015 and 2016. rational arguments of the future development in Eurozone: Year Germany Ireland Greece Portugal Spain Italy •• The currency union will not fall apart; the countries 2015 0.15 0.60 −11.964 −5.480 −4.971 −3.712 extremely affected by the adoption of the euro will 2016 0.37 2.73 −11.778 −4.438 −2.755 −2.397 remain the part of it. •• Much of the debt of the highly indebted states will be forgiven so that they could revitalize. productive activities were narrowly integrated into the Anglo-European economy. This opinion coincides with the The view of survival of monetary union in the present state is development of the output gaps in the years 2015 and 2016 also shared by Eichengreen and Wyplosz (2016) under the shown in Table 2; Ireland’s favorable recovery pace toward condition that the minimal requirements will be fulfilled. German economy is clearly identifiable from there (the These cover the decentralized fiscal policy, centralization of Ireland’s strong recovery was confirmed by a number of financial supervision, and monetary policy and debt restruc- analyses, for example, Fitzgerald, 2014; Keane, 2015; turing. Furthermore, the results of a number of statistical and Reeves & Palcic, 2017). As a matter of fact, Ireland’s fundamental analyses (e.g., those performed by Baum, recovery became apparent from 2013 and 2014 with an Checherita-Westphal, & Rother, 2013, and Égert, 2015), increase in Y and its future development depends on the confirm that to mitigate the effects of the unsuitable single factors that are beyond the control of national government currency in the long term, it is necessary to keep the public such as the stability in the international trade, private debt, debt and taxes within reasonable limits; these limits should oil prices, or the appreciation of the dollar and sterling vary for different economies. relative to the euro (Johnston & Regan, 2016). Updating the statistical outcomes of the analytical section Conclusive Summary with these empirical findings and scientific analyses, Ireland, due to its productive recovery, can be perceived as a part of The optimum currency area theory provides an analytical Group I; on the contrary, Italian after crises development framework for the functioning of a monetary union. One resembles the euro-economies of Group II rather than the premise of a successful monetary integration is linked to the economic development in Group I. The question of whether characteristics of the geographic area that has a high degree or not Europe can be regarded a single region in terms of a of mobility of factors inside and immobility of factors out- similar level of economic performance can be positively side, besides which, a similar economic structure and fiscal answered in the case of Austria, Luxembourg, Belgium, integration are required. The purpose of this article was to France, Finland, and the Netherlands. This result corresponds retrospectively identify euro-economies that met the assump- with Regan (2017), who claims that uniting together two dis- tion of similarity in the economic cycle for the period 2002- similar macroeconomic regimes (domestic demand-led mod- 2016 with the German economic cycle, which is conceived els, which prevail in southern Europe, and export-led models, as hegemonic euro-economy. which predominate the area of northern Europe) is the real For this purpose, the economies were analyzed wherein origin of the euro crisis. From the short-term analysis point the euro was the denominated currency before and inclusive of view, Ireland can be included as well. Since the financial of 2002 (Germany, Belgium, Austria, France, Luxembourg, crisis in 2007, persistent heterogeneity is identified in the Netherlands, Finland, Ireland, Greece, Spain, Italy, and Greece, Spain, Portugal, and Italy. This result is supported by Portugal) from the perspective of the degree of synchroniza- Miles and Vijverberg (2016), already referred to in the meth- tion with the cyclical position of Germany. The cyclical posi- odological part, whose empirical analysis led them to con- tion, expressed as an average of absolute values of differences clusion that adoption of a single currency increased of the output gaps of euro-countries and Germany, reflects the synchronization trend for nations ready for a single currency economic cycle in which each member country is found on (namely the states of Group I), but it increased desynchroni- average in relation to Germany. The greater the difference in zation of nations that were far from being synchronized yearly gaps of the product, the more severe the occurrence of before monetary unification (namely the states of Group II). dissimilarity in the economic cycle (the strongest dissimilari- The results imply that single monetary policy and a single ties were manifested in Greece, Ireland, Spain, and Portugal). exchange rate cannot work in the conditions of structurally This procedure was supplemented by correlation and com- different economies (Fabbrini, 2013). This is probably an parative analysis together with the assessment of empirical irreparable structural defect, which can be hardly healed by findings, which led to the conclusion that the western means of stabilization funds (Griffith-Jones & Ocampo, European countries can be perceived as a single region in 2009). Under the current political and economic circum- terms of a similar economic structure (Austria, Belgium, stances, we are inclined to the opinion of Sinn (2014), who, France, Luxembourg, the Netherlands, and Finland) and as 6 SAGE Open such can form an effectively functioning monetary union. The Égert, B. (2015). Public debt, economic growth and nonlinear effects: Myth or reality? Journal of Macroeconomics, 43, 226- assessment of the development in Eurozone for future decade was made taking into account the current political and eco- Eichengreen, B., & Wyplosz, C. (2016). Minimal conditions for the nomic circumstances and the outputs of empirical analyses. survival of the Euro. Intereconomics, 51, 24-28. Fabbrini, S. (2013). Intergovernmentalism and its limits: Assessing Declaration of Conflicting Interests the European Union’s answer to the Euro crisis. 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The Euro trap: On bursting bubbles, budgets, currency increase or decrease business cycle synchronization and beliefs. Oxford, UK: Oxford University Press. for its member countries? Economica. Advance online publica- van den Bergh, J. (2009). The GDP paradox. Journal of Economic tion. doi:10.1111/ecca.12201 Psychology, 30, 117-135. Montani, G. (2011). Money and finance as global public goods: Contribution to a supranational macroeconomic theory. SAGE Author Biographies Open, 1(3), 1-11. Simona Hašková is an assistant professor of business economy and Mundell, R. A. (1961). A theory of optimum currency areas. The finance at the Institute of Technology and Business. Her recent pub- American Economic Review, 51, 657-665. lications in English cover the topics of macroeconomic problems of OECD stat. (2016). Output gaps: Deviations of actual GDP from Eurozone, microeconomic analyses of firm processes, economic potential GDP as % of potential GDP (Economic Outlook analyses of renewable resources and decision making processes No. 99 [online]). Retrieved from http://stats.oecd.org/Index. based on fuzzy approach. aspx?QueryId=51655 Paterson, W. E. (2011). The reluctant hegemon? Germany moves Marek Vochozka is a professor of business economy and centre stage in the European Union. Journal of Common finance at the Institute of Technology and Business. His recent Market Studies, 49, 57-75. publications in English cover the topics of neuron networks Reeves, E., & Palcic, D. (2017). Getting back on track: The applications in the economy, economic analyses of renewable expanded use of PPPs in Ireland since the global financial cri- resources, analyses of economic consequences of environmental sis. Policy Studies, 38, 339-355. policy, etc. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png SAGE Open SAGE

Duality in Cyclical Trends in European Union Confirmed:

Hašková, Simona; Vochozka, Marek
SAGE Open , Volume 8 (1): 1 – Jan 20, 2018
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Abstract

This article differentiates the euro-economies in terms of the degree of synchronization with the cyclical position of Germany perceived herein as a hegemon economy. The purpose of this study is the identification of the euro-economies that can be identified as an effective monetary area in terms of similarity in economic structure with German economy. The cyclical position is expressed as an average of absolute values of differences of the output gaps between euro-countries and Germany. This procedure is supplemented by correlation and comparative analysis and with the assessment of empirical findings. Two groups are identified according to similarities in cyclical positions. Similar economic performance was ascertained in Austria, Belgium, France, Luxembourg, the Netherlands, and Finland, the economies of which are thus labeled as an effective currency region in the sense of optimum currency area. The assessment of the future development in Eurozone is made taking into account the current political and economic circumstances and the outputs of empirical analyses. Keywords effective currency area, optimum currency area, monetary policy, cyclical heterogeneity, Eurozone Krugman (2013) perceived Mundell’s theory of the opti- Introduction mum currency area as a theory about finding a balance between “The art of economics consists in looking not merely at the potential gains and losses in a qualitative sense. The success of immediate but at the longer effects of any act or policy; it monetary integration is conditioned by the existence of labor consists in tracing the consequences of that policy not merely mobility, a similar economic structure, and fiscal integration for one group but for all groups” (Hazlitt, 1946, p. 1). This (Kenen, 1969). The argument for the requirement of the com- thesis was, according to some economists (e.g., Krugman, pliance of a similar economic structure of the participating 2013), ignored in the case of the single currency euro states is to minimize the occurrence of such asymmetric shocks introduction. that would otherwise require different monetary policy inter- The theoretical and empirical aspects of the single mone- ventions (i.e., an effort to reduce cyclical heterogeneity in the tary policy were studied by many authors; among those stud- monetary union conjugate countries). The argument for the fis- ies, Mundell (1961) can be seen as one of the most significant cal integration policy leans on utilizing the opportunity of contributors. Mundell in his early work provided an analyti- mutual insurance against the asymmetric development of cal framework outlining the conditions for the thriving func- united economies; in such a case, it is possible for the country tioning of the monetary union. The main prerequisite of affected by a negative shock to obtain a positive net transfer successful monetary integration is linked to the characteris- from a country not affected. Fidrmuc (2015) remarked that if tics of the geographic area that has a high degree of labor the asymmetries are temporary, the effects of such an applied mobility factor inside and vice versa labor immobility factor “suboptimal” fiscal policy are short term and may be offset by outside (the optimum currency area). For that reason, such an the benefits of risk sharing under the terms of mutual fiscal area should have one currency inside and outside; it should insurance. However, if the shocks are of a permanent nature, have a flexible exchange rate; the labor mobility is seen as a fiscal transfers will become largely deterministic and unidirec- substitute for the exchange rate variability. As regards the tional with long-term costs burdening the donators. idea of monetary integration of Europe, Mundell literally says, “The question thus reduces to whether or not Western The Institute of Technology and Business in České Budějovice, Okružní, Europe can be considered a single region, and this is essen- Czech Republic tially an empirical problem.” In his later work, Mundell Corresponding Author: extended his analysis with a requirement for the stability of Simona Hašková, The Institute of Technology and Business in České the purchasing power of the integrated currency region Budějovice, Okružní 517/10, 370 01 České Budějovice, Czech Republic. (Fleming, Johnson, & Swoboda, 1973, p. 1). Email: haskovas@post.cz Creative Commons CC BY: This article is distributed under the terms of the Creative Commons Attribution 4.0 License (http://www.creativecommons.org/licenses/by/4.0/) which permits any use, reproduction and distribution of the work without further permission provided the original work is attributed as specified on the SAGE and Open Access pages (https://us.sagepub.com/en-us/nam/open-access-at-sage). 2 SAGE Open The economic slump in Europe activated by the 2007 performed empirical analysis, which showed that larger dif- financial crisis renewed the debate about the relationship ferences in output gaps indicate a more serious fluctuation between the economic cyclicality of the participating coun- in the phase of the economic cycle. tries and the efficiency of a monetary union in a situation of a nonexisting fiscal stabilization mechanism, limited mobil- Methodological Approach ity of labor factor, and economic heterogeneity of the mem- ber states (this issue was analyzed based on empirical data The analysis of cyclical synchronization/nonsynchronization given in Montani, 2011, or Collignon, 2013). of the monitored euro-economies entering the Eurozone In the context of the 2007 financial crisis, Fingleton, before and inclusive of 2002 compared with the German Garretsen, and Martin (2015) examined the vulnerability of economy in the period 2002-2016 of the economic cycle is heterogeneous economies bound by the euro. Their findings based on the quantification of the average difference of out- indicate that the larger the asymmetry of shocks across put gaps (Miles & Vijverberg, 2016, assessed cyclical syn- regions sharing single currency is, the more this area devi- chronization of Eurozone by means of a method of switching ates from the optimum currency area in terms of the mone- Markov models examining the changes in output). The out- tary policy implemented. Cancelo (2012) presented empiric put gap of each economy in a given year is the difference of evidence that the foundations, which explain the formation the real product (Y) and the potential product measured in of the national cycles across the European Monetary Union percentage of Y. The average of absolute values of differ- aggregated through the crisis, were already latent in 2007. ences of the output gaps of the monitored economies ( G ) Several authors have examined the influence of German (where G signs for an output gap of the ith economy at the interests on the formation of the European monetary policy. time t) and the reference economy ( G ) (wherein index G Kaltenthaler (2002) argued that the nature of the European denotes the output gap of reference economy R at the time t) monetary policy was influenced by German economic in the period t = 1; n is quantified by the relationship shown interests rather than the interests of European policy elites. in Equation 1; it defines the respective average deviation of From another perspective, the nature of the European mon- the cyclical position of the ith economy observed from the etary policy has been examined by Bulmer and Paterson cyclical position of the reference economy R. (2013). It focused on the analysis of the evidence of the t t hegemonic role of Germany, which is considered to be a X =⋅ GG − . (1) i R i key player in the field of EU policy (Krampf, 2014); spe- t=1 cifically, it deals with the interaction between Germany and The criterion defining the interface between the cyclical syn- the European Central Bank and the European Commission. chronized and unsynchronized euro-economies is the geo- Also, De Grauwe in 2013, saw the political objectives metric mean of the average deviations X calculated behind the decision to create the euro as a common cur- standardly according to Equation 2, where m stands for the rency with Germany and France being the main players in number of countries considered. Furthermore, the statistical this field; as for France, its inferior position that it occupied t t correlation of G and G is expressed and its relevance to R i in the European Monetary System initiated a proposal of the problem discussed. monetary union (as justified in Jabko, 1999, in detail); as 1/m for Germany, the ultimate goal of unification was to peren-   (2) GX =   . nially link the fates of France and Germany and thus to i   i=1   eliminate the danger of future wars on the European conti- nent (Ash, 2012). The imperfections of the criteria Y discussed by van den The purpose of this article is to differentiate the euro- Bergh (2009) are disregarded. Furthermore, it is assumed economies in terms of the degree of synchronization with that the potential output approximately expresses the highest the cyclical position of Germany (hereinafter “reference sustainable performance of the economies under the condi- region”). The cyclical position mirrors itself in the economic tion of disposable amount and quality of factors of produc- cycle in which euro-countries are found at a given time tion (Durlauf & Blume, 2008). when compared with the reference region. Within the analy- Potential product is considered to be a relatively good cri- sis, the assumption of the economic and political hegemony terion for depicting the state of the economy in the absence of Germany is accepted (based on the profound quantitative of demand and supply shocks in all markets (Gerlach & and qualitative analysis and rational arguments found in Smets, 1999). Although the identification of the disparity Paterson, 2011, and Bulmer, 2014). The synchronization/ between the real and potential product is ambiguous (it is not nonsynchronization of euro-economies with the reference clear to what extent it is, for example, a negative demand region is assessed by means of a statistical and comparative shock or a negative supply shock—both types of shocks analysis of the output gaps of gross domestic product for the within the metrics used reflect in the same direction, that is, period 2002-2016 (the data source was a publicly accessible in decline in the real output, though the monetary policy database: OECD.stat, 2016). Artis, Krolzig, and Toro (2004) response may not be identical), it can be considered as an Hašková and Vochozka 3 Table 1. The Cyclical Heterogeneity of Eurozone Countries in Comparison With the German Economy (Ranked in Ascending Order According to the Indicator of Average Deviation, X ). The average deviation from the cyclical position Eurozone of the German economy ( X ) (in % of Y for the R (the predictive power of r (correlation of output countries period 2002-2016) the regression model) [0, 1] gaps in 2002-2016) [–1, 1] Belgium 1.08 .38 .62 France 1.39 .27 .52 Luxembourg 1.4 .412 .87 Austria 1.5 .31 .56 Netherlands 1.54 .26 .51 Finland 1.93 .39 .62 Italy 2.16 .15 .39 Portugal 3.19 .008 .09 Spain 4.04 .025 .13 Ireland 5.66 .081 .28 Greece 7.73 .002 −.04 acceptable summarizing criterion (Apel & Jansson, 1999). to economies whose average deviation from the potential We agree with Mandel and Tomšík (2015) who consider the product is higher than 2.3% of Y compared with the refer- synchronization appraisal of economies according to the ence region—further referred to as Group II). growth rate as incorrect. The growth rate is a variable captur- The correlation coefficients r as well as the coefficients of ing the growth/decline of real product due to past perfor- determination R (see Table 1) can be considered as the mance expressed in percentage, which insufficiently implementation of statistical relations between the values of indicates the phase of the economic cycle in which the econ- the output gaps of the reference region and the surveyed omies are found. The product growth rates may be similar, euro-economies. These statistical measures are widely used although the phases of the economic cycle are fundamentally to explain macroeconomic relations, for example, in Bianchi different and require different interventions of monetary pol- and Civelli (2015), Kiley (2013), or Havránek (2010). icy (Grossman & Helpman, 1993). However, as Den Haan (2000, p. 3) pointed out, “uncondi- tional correlation coefficients lose significant information about the dynamic aspects of the co-movement across vari- Analysis of Cyclical Heterogeneity of ables.” In case of nonstationary variables, the unconditional Euro-Economies According to Output correlation produces spurious estimates—as they do not Gaps imply causation. Therefore, it is necessary to consider their substantive contribution to the analysis according to other The impacts of demand and supply shocks on the Eurozone standards. The degree of similarity in terms of r and R is, countries during the period 2002-2016 depict the respective therefore, assessed by means of the comparative approach positions of cyclical deviations of the monitored economies whose results are captured in Figure 1. The regression lines from the cyclical position of the reference economy. The there define a relationship between the reference region and cyclical deviations calculated according to Equation 1 are the surveyed euro-economies. This relation leans on the summed up in Table 1. The higher the value, the greater the assessment of the cyclical positions of the euro-economies of divergence of the cyclical position of the countries surveyed Ireland, Greece, Luxembourg, and Austria, and the reference compared with the reference region. region by means of the analysis of annual deviations from According to the criterion of “synchronization,” it is pos- the potential product for the period 2002-2016. sible to identify the degree of similarity of the economic The relationship between the components of the cyclic posi- cycle in Austria, Belgium, France, Luxembourg, the tion of Ireland and the cyclic position of the reference region Netherlands, Finland, and Italy (further referred to as Group (see the upper left graph of Figure 1) exhibits a low value of the I) with the German economy. Similar development is identi- coefficient of determination (R = .08) as well as a low value of fied in the countries whose average deviation from the cycli- correlation (r = .28). From Figure 1, it can be specifically cal position of Germany is located in the range [0, 2.3] learnt, for example, that when the output gap in the reference percentage of Y in the selected period (see Table 1). The economy was above the potential by 0.71%, 2.57%, 0.59% and upper border value 2.3 is given by the geometric mean of the 0.03% of Y, the corresponding values of output gaps in Ireland average deviations (see Equation 2). Conversely nonsyn- amounted to 8.46%, 9.42%, –6.31%, and –4.51% of Y. In the chronization is identified in the case of Ireland, Greece, and case of the under potential values of –1.58%, –1.75%, and Spain, and to a lesser extent in Portugal (the property of –1.9% of Y of the reference region, the Irish output gap was asynchronous development of the cyclical position is related 4 SAGE Open Figure 1. The output gaps in percentage of Y of the reference region versus output gaps in euro-countries Ireland, Greece, Luxembourg, and Austria. 7%, 7.02%, and –7.15% of Y. From this, the disproportion in cyclical deviations of Group II can, however, be deemed as the cyclical positions can be clearly seen. The right upper graph more or less disadvantaged by the single monetary policy. De compares the output gaps of the reference region with the out- Grauwe and Foresti (2016) gave reasons for such a distribu- put gaps of Greece also revealing a strong disparity in the eco- tion pointing to the loss of ability of these economies to nomic cycle (R = .002, r = –.04). The relationship between the improve the strong asymmetric division by an appropriate output gaps of Germany and Luxembourg (see the bottom left manipulation of exchange rates to correct the real flow of graph of Figure 1, with R = .412, r = .87) shows substantial goods and services within international trade and to appro- synchronization compared with previous cases. This also priately influence national interest rates (Coudert, Couharde, applies for Austria (R = .31, r = .56), whose position of the & Mignon, 2013). output gaps of Y compared with Germany is shown in the bot- The empirical development of euro-economies studied tom right graph of Figure 1. The same can be concluded in the in Barigozzi, Conti, and Luciani (2014) and Duwicquet, 2 2 cases of Belgium (R = .38, r = .62), France (R = .27, r = .52), Mazier, Petit, and Saadaoui (2015) pointed to the strong 2 2 Netherlands (R = .26, r = .51), and Finland (R = .39, r = .62). cyclical heterogeneity of Italy owing to the idiosyncratic nature that can barely be coordinated by the single mone- tary policy ( X = 2.16% of Y, which lies on the division Italy Discussion line between Group I and II; see Table 1). Coudert et al.’s The monetary transmission mechanism being changed by the (2013) analysis quantified the degree of currency over- euro introduction has in general resulted in different valuation in 2010 to which contributed the fall of net for- responses in the two groups of euro-economies (see analyti- eign assets and productivity regression in Greece, Spain, cal part above). On the basis of a distribution of the euro- and Portugal, and to a lesser extent also in Italy. Conversely, countries to Group I and Group II, let us consider that the Hardiman, Blavoukos, Dellepiane, and Pagoulatos (2016) Group I has not been significantly weakened by the single noted that Ireland began to escape the after 2008 crisis monetary policy effects. Euro-economies with the severe stagnation of Greece, Spain, Italy, and Portugal as its Hašková and Vochozka 5 Table 2. The Heterogeneity in Outputs Gaps (percentage of Y) based on empirical data and the past and current political and of Ireland, Portugal, Greece, Spain, and Italy Compared with the economic development in the European Union, submitted Output Gaps of Germany in 2015 and 2016. rational arguments of the future development in Eurozone: Year Germany Ireland Greece Portugal Spain Italy •• The currency union will not fall apart; the countries 2015 0.15 0.60 −11.964 −5.480 −4.971 −3.712 extremely affected by the adoption of the euro will 2016 0.37 2.73 −11.778 −4.438 −2.755 −2.397 remain the part of it. •• Much of the debt of the highly indebted states will be forgiven so that they could revitalize. productive activities were narrowly integrated into the Anglo-European economy. This opinion coincides with the The view of survival of monetary union in the present state is development of the output gaps in the years 2015 and 2016 also shared by Eichengreen and Wyplosz (2016) under the shown in Table 2; Ireland’s favorable recovery pace toward condition that the minimal requirements will be fulfilled. German economy is clearly identifiable from there (the These cover the decentralized fiscal policy, centralization of Ireland’s strong recovery was confirmed by a number of financial supervision, and monetary policy and debt restruc- analyses, for example, Fitzgerald, 2014; Keane, 2015; turing. Furthermore, the results of a number of statistical and Reeves & Palcic, 2017). As a matter of fact, Ireland’s fundamental analyses (e.g., those performed by Baum, recovery became apparent from 2013 and 2014 with an Checherita-Westphal, & Rother, 2013, and Égert, 2015), increase in Y and its future development depends on the confirm that to mitigate the effects of the unsuitable single factors that are beyond the control of national government currency in the long term, it is necessary to keep the public such as the stability in the international trade, private debt, debt and taxes within reasonable limits; these limits should oil prices, or the appreciation of the dollar and sterling vary for different economies. relative to the euro (Johnston & Regan, 2016). Updating the statistical outcomes of the analytical section Conclusive Summary with these empirical findings and scientific analyses, Ireland, due to its productive recovery, can be perceived as a part of The optimum currency area theory provides an analytical Group I; on the contrary, Italian after crises development framework for the functioning of a monetary union. One resembles the euro-economies of Group II rather than the premise of a successful monetary integration is linked to the economic development in Group I. The question of whether characteristics of the geographic area that has a high degree or not Europe can be regarded a single region in terms of a of mobility of factors inside and immobility of factors out- similar level of economic performance can be positively side, besides which, a similar economic structure and fiscal answered in the case of Austria, Luxembourg, Belgium, integration are required. The purpose of this article was to France, Finland, and the Netherlands. This result corresponds retrospectively identify euro-economies that met the assump- with Regan (2017), who claims that uniting together two dis- tion of similarity in the economic cycle for the period 2002- similar macroeconomic regimes (domestic demand-led mod- 2016 with the German economic cycle, which is conceived els, which prevail in southern Europe, and export-led models, as hegemonic euro-economy. which predominate the area of northern Europe) is the real For this purpose, the economies were analyzed wherein origin of the euro crisis. From the short-term analysis point the euro was the denominated currency before and inclusive of view, Ireland can be included as well. Since the financial of 2002 (Germany, Belgium, Austria, France, Luxembourg, crisis in 2007, persistent heterogeneity is identified in the Netherlands, Finland, Ireland, Greece, Spain, Italy, and Greece, Spain, Portugal, and Italy. This result is supported by Portugal) from the perspective of the degree of synchroniza- Miles and Vijverberg (2016), already referred to in the meth- tion with the cyclical position of Germany. The cyclical posi- odological part, whose empirical analysis led them to con- tion, expressed as an average of absolute values of differences clusion that adoption of a single currency increased of the output gaps of euro-countries and Germany, reflects the synchronization trend for nations ready for a single currency economic cycle in which each member country is found on (namely the states of Group I), but it increased desynchroni- average in relation to Germany. The greater the difference in zation of nations that were far from being synchronized yearly gaps of the product, the more severe the occurrence of before monetary unification (namely the states of Group II). dissimilarity in the economic cycle (the strongest dissimilari- The results imply that single monetary policy and a single ties were manifested in Greece, Ireland, Spain, and Portugal). exchange rate cannot work in the conditions of structurally This procedure was supplemented by correlation and com- different economies (Fabbrini, 2013). This is probably an parative analysis together with the assessment of empirical irreparable structural defect, which can be hardly healed by findings, which led to the conclusion that the western means of stabilization funds (Griffith-Jones & Ocampo, European countries can be perceived as a single region in 2009). 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The Euro trap: On bursting bubbles, budgets, currency increase or decrease business cycle synchronization and beliefs. Oxford, UK: Oxford University Press. for its member countries? Economica. Advance online publica- van den Bergh, J. (2009). The GDP paradox. Journal of Economic tion. doi:10.1111/ecca.12201 Psychology, 30, 117-135. Montani, G. (2011). Money and finance as global public goods: Contribution to a supranational macroeconomic theory. SAGE Author Biographies Open, 1(3), 1-11. Simona Hašková is an assistant professor of business economy and Mundell, R. A. (1961). A theory of optimum currency areas. The finance at the Institute of Technology and Business. Her recent pub- American Economic Review, 51, 657-665. lications in English cover the topics of macroeconomic problems of OECD stat. (2016). Output gaps: Deviations of actual GDP from Eurozone, microeconomic analyses of firm processes, economic potential GDP as % of potential GDP (Economic Outlook analyses of renewable resources and decision making processes No. 99 [online]). Retrieved from http://stats.oecd.org/Index. based on fuzzy approach. aspx?QueryId=51655 Paterson, W. E. (2011). The reluctant hegemon? Germany moves Marek Vochozka is a professor of business economy and centre stage in the European Union. Journal of Common finance at the Institute of Technology and Business. His recent Market Studies, 49, 57-75. publications in English cover the topics of neuron networks Reeves, E., & Palcic, D. (2017). Getting back on track: The applications in the economy, economic analyses of renewable expanded use of PPPs in Ireland since the global financial cri- resources, analyses of economic consequences of environmental sis. Policy Studies, 38, 339-355. policy, etc.

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SAGE Open – SAGE

Published: Jan 20, 2018

Keywords: effective currency area; optimum currency area; monetary policy; cyclical heterogeneity; Eurozone

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